At the present time, when there is a danger of interest rates going upwards, there is a question among investors – which funds are appropriate and which funds should exit. Before discussing the guidance part, let us look at some relevant facts for easy understanding.
The 16 debt fund categories are defined by SEBI in terms of references i.e. what a fund should do in that category. Therefore, when you decide to invest in a fund, you can take a look at the parameters of that category and get a fair idea.
Debt funds earn their returns from two avenues: actuaries and mark-to-market (MTM). Accrual is a coupon or interest that accumulates on bonds and other instruments in the portfolio. The mark-to-market valuation is done every day, for NAV computations, according to the prevailing market prices for equipment in the portfolio. Yield (interest rate) and bond prices move inversely; If the yield level rises, prices come down and the MTM effect is unfavorable. If interest rates are low in the market, the effect is positive.
When market yields or interest rates rise, the immediate effect is adverse. However, over a period of time, the accrual level goes up. Fresh money coming into the fund is invested in high yields and, as the securities mature, reinvestment occurs at high yields.
The longer your investment horizon, the better. You have too much accrual to absorb any MTM damage. Also, over a long period of time, the market moves in cycles i.e. interest rates rise and fall, and then settle down.
For example, suppose a debt fund has a portfolio of 100 100 and on a bad day, the adverse MTM effect was debt 1.5. The accrual level of the fund is 6%. If you had invested in the fund the day before, you would see minus 1.5% in your statement. If you stay invested for three months, your returns will be zero because the fund has / 6/4 =. Had accumulated 1.5. In a one-year holding period, your return is ₹ 6 minus ie 1.5, ie 4.5%.
If you have a 10-year horizon, it will be said that it will be more robust and the impact of MTM will be negligible. If noted, the MTM effect can be favorable even when the level of yield is coming down.
The portfolio maturity of a debt fund is the weighted average maturity of all instruments in the portfolio. The greater the maturity of the portfolio, the greater the variability in market movements. In other words, MTM effects with greater maturity are more mature and regressive. In this sense, low maturity funds are defensive.
With this background, now we have to guide what to do:
Given that yields / interest rates are expected to increase gradually over the next year, a shift from long-maturity debt funds to short-maturity is appropriate. Saying that, if you have a sufficiently long investment horizon, you can also invest in a long maturity fund. As noted earlier, longer time periods and multiple market cycles will also exclude interim volatility.
If you cannot digest volatility, you can gradually move from a long maturity fund to a shorter maturity. On an adequate investment horizon, there is no hard and fast definition; The ballpark is, if your horizon is more-or-less equal to the maturity of the portfolio, you are protected. As an example, for a fund with a three-year portfolio maturity, a three-year horizon is sufficient and for a 10-year maturity fund, a 10-year horizon is desirable.
Also check the quality of the portfolio. If your horizon is called three years and long, there are funds in the categories of banking and PSUs, corporate bonds, short-term, etc., to achieve tax efficiency. Fact sheet of the fund you wish to invest in is available. AMC's website. All the details of portfolio maturity, portfolio structure etc. are available on the fund fact sheet.
From a credit risk perspective, government security funds are the best. However, these funds have relatively longer maturity periods and are more volatile. Hence a long investment horizon is necessary for G-Second Fund.
For the deployment of fresh money, which does not have the benefit of earned money as you had already invested, think about the situation you have and whether you prefer the initial volatility that can occur if yields rise. And MTM is counterproductive. For existing investments, if it is in a long maturity fund and you want to stay for three years for tax efficiency and you are close to three years, you can keep.
Yields are expected to be top-down gradual and calibrated. If you have completed three years and your corpus is already taxable, then it is a matter of the rest of the horizon. If the remaining investment period is called six months or one year, you can move to a shorter maturity. If your remaining period is a few more years, you can keep.
There is a common belief that in a rising interest rate scenario, floating rate funds are reasonable because it would benefit from rising interest rates. However, this is not a one-to-one correspondence. Interpretation is technical; Simply put, real floating rate bonds, where the coupon rate is benchmarked to say MIBOR (which runs with RBI defined rates) are rare. These fund portfolios are constructed as “synthetic floaters”.
If you are working with a consultant or distributor, you can seek guidance. If you are a DIY, you can review your debt fund portfolio according to the criteria discussed above. Note, the probability of increase in yields in the next one year will be gradual and you will have time to execute any changes.
(The author is a corporate trainer (loan market) and author)